Cost-benefit analysis
Cost-benefit analysis (CBA) is a method which helps us to determine if intended project is worthwhile. We often get involved in cost-benefit analysis unconsciously in our lives when weighing pros and cons of the decision we are going to make. It is widely used by politicians in estimating benefits of projects concerning social sphere, criminal justice, environmental issues and many more. While being controversial when it comes to precise evaluation, it is still of great help with making rough estimates for upcoming policy changes. Speaking straight, CBA is a technique attempting to express in money terms all of the possible pros and cons of a certain decision.
Cost-benefit analysis was firstly introduced in France by Jules Dupuit over 150 years ago. Nevertheless, it has found a widespread use only in the 1930s in the USA. Since then economists have developed sophisticated theories and principles of CBA and now it is widely used for estimation and analysis in making political decisions concerning the environment, social sphere, construction etc.
While for some of the parts of costs and benefits computation is intuitively obvious for other ones measurement in dollars hardly undergoes intuitive suggestions. How to express in money value pollution of the environment or the decrease in time spent traveling?
Despite being opposites, costs and benefits are computed the same way. Benefits are the expression of the desire to pay for the results of the policy changes being implemented. Costs are the compensation needed for the negative consequences of the changes. In both cases, the reference point is the well-being without policy change.
For the evaluation of costs and benefits that can’t be evaluated directly, market choices are commonly used. For example, when talking about environmental pollution the difference between house prices in clean and polluted areas is used. For the decrease in time spent travelling benefits can be estimated as the eagerness to pay for the nearby parking rather than travel on feet for several minutes for free. When it comes to the evaluation of human life in CBA they operate with the risk of death. It is expressed in people agreeing for a higher risk for a higher pay (oil platforms’ workers, miners) or time economy (travelling at higher speeds). For health risks the frequency of visits to the doctor and their cost can be taken in concern.
Project or policy change is considered worthwhile if the benefits outweigh the costs. Still, there are couple issues concerning the CBA. One is the evaluation of benefits, effects of which are long delayed i.e. climate changes, global warming, genetic changes etc. The value of their impact is discounted resulting in a huge underestimation. Another one is the distribution of income. Regarding the same desire for the improvement, people with different income will be willing to pay different prices for it.
While having some flaws and limitations CBA still remains crucial to making political decisions and implementing new projects.
References
Portney, P. R. (n.d.). Benefit-Cost Analysis: The Concise Encyclopedia of Economics | Library of Economics and Liberty. Retrieved from http://www.econlib.org/library/Enc/BenefitCostAnalysis.html
